Investment Clock - Where are we now?

At the start of a new year, it is good to set out some expectations for the marco economic conditions and hence the likely impact/ effect on stock market conditions. One very good chart is the Merrill Lynch Investment Clock which shows the different phases of growth in different classes of asset and the interactions with interest rates and inflations.

As it is now, US FED rates have been rising and is now standing at 4.25% compared with 2.25% exactly a year ago. It is expected to increase for another 25 basis points before any pausing. Dow Jones closed at 10,717.50 on 30 Dec 2005 compared with 10,783.01 on 31 Dec 2004, ended the year relatively flat. The US economy is expected to be moderated and slowed down as US tries to reduce its trade deficits via interest rate policy. As interest rate peaks, i.e. at the bottom of the above chart, it may be the best time to invest in US bonds while reducing weightage on stocks.

Over the past few months, Singapore interbank rates have also been increasing. One-year SGS Treasury bill has a 2.85% yield as of Dec'05 compared with only 1.55% in Jan'05. My expectation for short term interest rate is somewhere between 3.50% to 4.00% for the coming year. Domestic interbank rates for 3, 6 and 12 months are now all at 3.25%. In this raising interest environment, business costs are likely to increase, investors may prefer to invest more in interest yield assets and reduce higher risk stocks. Hence, for year 2006, it may be more prudent to maintain some amount of cash instead of being fully invested in stocks as historically, stock market performance has an inverse relationship with interest rate. This phenomenal is yet to be fully seen in US markets. Once US begins to slow down, it may be the signal for SGX to follow likewise. Hence, to thread with care.